Crypto taxes can take a significant bite off your profits. While you can’t avoid paying taxes, you can certainly reduce the taxes you pay. What you need is some careful planning and smart crypto accounting. Although many investors look to reduce taxes at the end of the year, the truth is that they have opportunities throughout the year to reduce their tax profile. In this post, the team at Onchain Accounting will be breaking down how you can reduce your crypto taxes with smart crypto accounting.
How is crypto taxed in the United States?
In the US, cryptocurrency and other crypto assets are treated as property. As a result, transactions are subject to ordinary income tax and capital gains tax. The income received from mining, staking, and airdrops can be subject to ordinary income tax.
On the other hand, selling crypto assets for fiat currencies, trading/swapping crypto, and paying for goods and services using crypto can be subject to capital gains tax. The capital gains tax rate applicable depends on when the asset is dealt with. As such, capital gains are broken down into short-term and long-term capital gains taxes.
Another point worth noting is that when the IRS calculates taxes, First-in, First-out (FIFO) is the default accounting method. Under this method, it is presumed that the oldest asset in your wallet is the first to leave the wallet, making for higher capital gain that can be taxed.
How can you reduce your taxes?
Tax loss harvesting
Tax loss harvesting is the process of selling cryptocurrencies that have decreased in value to offset the capital gains of one of your profitable investments. This helps reduce your overall taxable income and transform unrealised losses into realised losses.
Using tax-advantaged accounts
Using special accounts like a Roth or Traditional IRA to store your cryptocurrency can offer numerous tax advantages. In Roth IRA accounts, contributions are taxed upfront, and withdrawals are tax-free. On the other hand, traditional IRA contributions are tax-deductable, meaning that withdrawals are subject to tax.
Holding cryptocurrency in the long term
Certain crypto transactions are subject to short-term and long-term capital gains tax. A person will be subject to short-term tax when they hold an asset for less than a year. Conversely, they will be subject to the long-term tax rate when they hold the asset for more than a year. The long-term capital gains tax offers a more favourable tax rate, currently standing between 0 and 20%. On the other hand, short-term capital gains tax stands between 10% and 37%.
Choosing the most suitable inventory method (FIFO, LIFO, or specific identification)
Choosing the right accounting method can go a long way to reducing your tax liability. The most common methods of inventory management used for crypto taxes are First-in, First-out (FIFO); Last-in, First-out (LIFO); and Specific Identification. In some cases, LIFO can prove more advantageous, showing a lower capital gain, which extends to a lower tax profile. Contact your tax agent or crypto CPA to see how the inventory method can impact your portfolio.
Gifting cryptocurrency
Gifting cryptocurrency is considered a non-taxable transaction. Gifting crypto to your family or friends allows you to transfer wealth without triggering tax liabilities, allowing you to reduce your taxable estate. However, you must keep in mind that the recipient will inherit your cost basis, which will impact the capital gains calculations when they sell.
Conclusion
Your crypto transactions are subject to a number of taxes, and if you’re not careful, you will end up paying more than you should. From loss harvesting to choosing the right accounting method, reducing your crypto tax liability is all about making informed strategic decisions. That is where on-chain accounting can help.
At Onchain Accounting, our team plays the role of cryptocurrency accountant for many individual investors and businesses. We help everyone keep their records clean, organized, and compliant. At the same time, we identify the opportunities and lay the groundwork for tax savings throughout the year. Ready to take action and reduce your tax liability? Contact Onchain Accounting and schedule a meeting today.